Question

Testing Company, Inc. has the following combination of Debt and Equity:

Common Stock:

15.5 million shares outstanding

Par value of $5/share

Book value of $20/share

Current price on the market of $65.25

Current Beta per a reliable source 1.13

Debt:

Maturity value of $500,000,000

Current price on the market of 97.3

Coupon rate if 4%

Semiannual payments

10 years until maturity

Other information:

Treasury bill rates — 2.45%

Market premium on this type of stock — 7.1%

Tax rate — 21%

What is the company’s weighted average cost of capital (WACC)?

Answer 1

MV of equity=Price of equity*number of shares outstanding

MV of equity=65.25*15500000

=1011375000

MV of Bond=Par value*bonds outstanding*%age of par

MV of Bond=1000*500000*0.973

=486500000

MV of firm = MV of Equity + MV of Bond

=1011375000+486500000

=1497875000

Weight of equity = MV of Equity/MV of firm

Weight of equity = 1011375000/1497875000

W(E)=0.6752

Weight of debt = MV of Bond/MV of firm

Weight of debt = 486500000/1497875000

W(D)=0.3248

Cost of equity

As per CAPM

Cost of equity = risk-free rate + beta * (Market risk premium)

Cost of equity% = 2.45 + 1.13 * (7.1)

Cost of equity% = 10.47

Cost of debt

K = Nx2

Bond Price =∑ [(Semi Annual Coupon)/(1 + YTM/2)^k]     +   Par value/(1 + YTM/2)^Nx2

k=1

K =10x2

973 =∑ [(4*1000/200)/(1 + YTM/200)^k]     +   1000/(1 + YTM/200)^10x2

k=1

YTM = 4.3356184219

After tax cost of debt = cost of debt*(1-tax rate)

After tax cost of debt = 4.3356184219*(1-0.21)

= 3.425138553301

WACC=after tax cost of debt*W(D)+cost of equity*W(E)

WACC=3.43*0.3248+10.47*0.6752